Question

Explain the difference between profit and contribution in an objective function. Why is it important for the decision maker to know which of these the objective function coefficients represent?

Answer 1

The basic difference in the profit and contribution is that the profit is seen as the difference between total cost and total revenue while in case of margin, it is represented as the difference between the total revenue and total variable cost. So the objective function will include total revenue, total fixed cost and total variable cost in case of profit while in the case of contribution, the objective function will not have any consideration for the fixed cost and it will include only the total revenue and total variable cost

It is important for the decision-maker to know which coefficient represents each of these as this will help him to decide whether the company is able to recover all the expenses or not. So when total fixed cost is added in the objective function, the total profit received will be less than the amount determined from the total contribution as it does not includes the fixed cost